Roughly 75% of underwater mortgages securitized into private-label bonds could be eligible for a refinance under the new plan from Sen. Jeff Merkley, D-Ore., according to analysts at JPMorgan Chase (JPM).
The proposal would allow a Rebuilding American Homeownership Trust buy underwater mortgages with revenue from government bonds. The trust would be assembled either in the Federal Housing Administration, the Federal Home Loan Banks system or the Federal Reserve.
Principal would be reduced, and the loans would be refinanced into FHA-backed mortgages. The trust would profit off the difference between the interest earned on the new loan and the cost of borrowing money through the bonds, according to the plan.
While Merkley said the program would target roughly 8 million borrowers, bank analysts anticipate less participation.
Roughly 1.2 million nonagency mortgages with loan-to-value ratios above 100% could benefit from the program, according to Chase analysts.
Borrowers would be able to refinance into either a 15-year 4% mortgage, a 30-year fixed-rate mortgage at 5%. Borrowers could also split the new loan into a 30-year fixed on 95% of the property's value and a "soft second" on the remaining balance, which the borrower wouldn't have to pay on for five years.
More than three-fourths of these borrowers would choose to split the refinanced loan into a "soft second," according to analysts.
"Of course there are a lot of details that would need to be ironed out. After all, this is effectively forming (or building upon) another GSE," Chase analysts said. "While we can see clear benefits for both borrowers and investors, the devil is in the details."
Banks with large amounts of underwater mortgages would be unlikely to participate. Refinances aren't like modifications. They must be offered to all borrowers who qualify, and many banks and servicers have been reluctant to write down principal for delinquent underwater borrowers, let alone current ones.
Borrowers with severely underwater mortgages would likely be shut out. Servicers must reduce principal to at least 140% LTV. In the analysts' example, a borrower with a $340,000 mortgage at 170 LTV (owes 70% more on the loan than the house is worth) would need $60,000 reduced. Along with an $18,000 risk-transfer fee, the lender would likely lose $78,000 on the deal, and the risk of default would still remain.
Treasury Department Secretary Timothy Geithner testified before the Senate Banking Committee last week that he thought the Merkley plan was a good one and would work with the senator on possibly producing a pilot program, maybe even using unspent Hardest Hit Funds.
Chase analysts estimated that more than 525,000 borrowers with private-label loans could refinance into full 30-year fixed mortgages and save an average $207 per month or $1.3 billion total every year.
Celia Chen, senior director at Moody's Analytics, said the program would also help borrowers rebuild equity faster and significantly reduce the risk of default.
"Moreover, it would benefit the broader economy, as refinancing frees up cash for consumer spending and generates business for mortgage originators and servicers," Chen said.
But other questions remain such as selecting a servicer for the RAH Trust loans. It also remains unclear if trusts could participate in the program.
"Clearly, bonds with the highest concentration of current borrowers will benefit the most if this program will reach nonagency trusts," Chase analysts said. "We expect any pilot program to target bank loans first."